Insights | 05.06.2020
A currency is usable if it can reliably be counted on to maintain its relative value over time and without depreciating. In many societies throughout history, commodities or precious metals were used as methods of payment because they were seen as having relatively stable value. Rather than require individuals to carry around cumbersome quantities of cocoa beans, shells, gold or other early forms of currency, societies eventually turned to minted currency as an alternative.
The introduction of paper money in 11th Century China was the next evolution – paper has little to no intrinsic value, but a bank note obtains value because it could be exchanged for a specified amount of gold held by the government or central bank – a system known as the ‘gold standard’. This system lasted until the 1970’s when President Nixon severed the relationship between the Dollar and gold and ushered in the age of fiat currencies.
Most modern currencies are fiat, including the US Dollar, British Pound and Euro. Fiat currencies are issued by a government and not backed by gold, but instead have value because of the faith that individuals and governments have that other parties will accept that currency
However, the age of central-bank issued fiat currencies is being challenged. In 2008 a new idea was introduced by an unknown person or group using the name “Satoshi Nakamoto” – Bitcoin.
Bitcoin is a decentralized digital currency without a central bank or government backing it. Bitcoin can be sent between users on the bitcoin network without the need for intermediaries.
Bitcoin relies on a technology called blockchain - a list of records (blocks) that are linked by cryptography – hence ‘cryptocurrency’. Each block contains a timestamp, a cryptographic tag of the previous block and transaction data. Blockchain is highly secure, fast and hard to tamper with as changes to a block must be validated by a majority of users within the system. This makes it great for transferring sensitive data, including contracts, shareholder details, medical records or money transfers.
Bob, an online merchant, decides to begin accepting Bitcoin as payment. Alice, a buyer, has Bitcoin and wants to purchase merchandise from Bob.
Since the launch of Bitcoin, cryptocurrencies have rarely been out of the headlines, prompting increased investor interest and a raft of competing currencies. Estimates vary on the number of cryptocurrencies, research site CoinMarketCap tracks over 5,000, but few of these have ever come close to Bitcoins meteoric popularity.
The crypto market may sound crowded, but it’s also extremely top-heavy with the majority of the investor adoption, capitalization and liquidity concentrated in the top 10 largest coins. Even among the heavy weights, Bitcoin is by far the dominant cryptocurrency with well over half of all market capitalization and greatest acceptance by users.
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In the same way that previous generations would swing a pickaxe in a mine for gold and silver to make coins, it takes effort to get a Bitcoin. Bitcoin mining is the way new Bitcoins are added to the available supply and involves very powerful computers called ‘miners’ solving complex mathematical problems to confirm and validate changes to the blockchain ledger. Miners who succeed in solving the problems are given Bitcoins, but it becomes harder to solve these problems over time and there is a finite number of Bitcoins to be mined.
There are rules built in to limit the total supply to 21
million Bitcoins making it a ‘hard’ currency compared
to fiat currencies controlled by central banks that can
devalue their currency by simply printing more money
Once mined, a Bitcoin can be used in peer-to-peer transactions over the Bitcoin network, spent on ecommerce sites (and in some physical stores) or withdrawn as fiat currency from one of the estimated 7,000 Bitcoin ATMs worldwide.
As with all currencies, Bitcoin’s value is determined by supply and demand and trust and acceptance in the system. A successful currency needs to meet standards of scarcity, divisibility, transferability and utility. Bitcoin’s value comes from the fact that it meets and often surpasses traditional currencies in delivering these features, and is therefore accepted by users as a useful tool for transactions and trading
Key to the maintenance of a currency's value is its supply. A money supply that is too large could cause prices of goods to spike, resulting in economic collapse. A money supply that is too small can also cause economic problems. Bitcoin is actually a hard currency, with a defined and finite supply hardwired within its codebase - unlike fiat currencies where governments or central banks have the power to increase the money supply at will
When Bitcoin was launched in 2009, its developer(s) capped the supply of tokens at 21 million. The current supply of Bitcoin is around 18 million and the rate at which Bitcoin is released is halved roughly every four years. The supply released should hit 19 million 2022. The last Bitcoin is not on track to be mined until ~2140.
Successful currencies are divisible into smaller incremental units. In order for a single currency system to function as a medium of exchange across all types of goods and values within an economy, it must have the flexibility associated with this divisibility. The currency must be suciently divisible so as to accurately reflect the value of every good or service available throughout the economy
21 million Bitcoins is vastly smaller than the circulation of most global currencies. However, to address this imbalance, Bitcoin is divisible up to 8 decimal points. The smallest unit, equal to 0.00000001 Bitcoin, is called a "Satoshi" after the alleged creator of the cryptocurrency. This allows for quadrillions of individual Satoshis to be distributed throughout the global economy.
A currency must have utility in order to be effective. Individuals must be able to reliably trade units of the currency for goods and services. This is a primary reason why currencies developed in the first place: so that participants in a market could avoid having to barter directly for goods. Utility also requires that currencies be easily moved from one location to another. Burdensome precious metals and bulky commodities don't easily meet this stipulation.
One of the biggest selling points of Bitcoin has been its use of blockchain technology. Blockchain is a distributed ledger system which is decentralized and trustless, meaning that no parties involved in the Bitcoin market need to know or trust one another in order for the system to work properly. A complex system of checks and verifications is key to the maintenance of the ledger and the mining of more Bitcoins. This means Bitcoin can’t be manipulated by individuals, governments or central banks
Currencies must be easily transferred between participants in an economy in order to be useful. In fiat currency terms, this means that units of currency must be transferable within a particular country's economy as well as between nations via exchange. With cryptocurrency exchanges, wallets, ATMs and other tools, Bitcoin is easily and securely transferable between parties
In fact, when compared to Gold and Fiat currencies, Bitcoin is more ‘money-like’ than money.
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Despite these many desirable characteristics, many investors still perceive Bitcoin as an unstable, risky asset that is complicated to trade and open to abuse. Stories of crypto frauds and failures and the collapse of high-profile crypto exchanges like Mt Gox still loom large in many investors’ minds. Additionally, the complexity of managing a Bitcoin wallet, trading on largely unregulated crypto exchanges, local regulatory restrictions and lack of availability of Bitcoin on broker and wrap platforms has impeded adoption from traditional asset and wealth managers.
The future of Bitcoin as legal tender and as an investment asset will depend on a number of factors. A solid regulatory framework will help create a more transparent market and if more protections are offered to investors, more will
be attracted to the market. In turn, this will build confidence in the cryptocurrency market and lead to greater
pricing eciencies. The treatment of capital gains from investments in Bitcoin will also catalyse the further development of the market. Lastly, confidence in the Bitcoin market will be improved if two disadvantages are properly
addressed—namely, complexity and insecurity.
Solutions are now becoming available that can provide access to the powerful diversification and return potential of Bitcoin in a regulated, transparent and exchange-listed structure that is as easy to trade as any share or ETF.
Important: Cryptocurrencies are highly volatile. Your capital is at risk. The value of cryptoassets can go down as well as up and you can lose your entire investment. ETC Management Limited, its affiliates, and subsidiaries are not soliciting any action based upon the material presented above. The material does not represent or shall not be inferred as an offer or a recommendation to buy or sell a security, nor shall it be considered or treated as investment advice.
Insights | 05.06.2020